After the Federal
Reserve launched QE3 last month, investors and speculators are
growing excited about its future impact on gold and silver. Though
the Fedís QE3 campaign started out relatively small, its open-ended
nature is utterly unprecedented. Thus an unknown amount of future
inflation will be spawned. Naturally gold and silver thrive in such
environments, as they proved during QE1 and QE2.

Of course QE
stands for quantitative easing. Even as a lifelong student
of the financial markets, I donít recall hearing this term before
late 2008ís epic stock panic. Central banks are notorious for
trying to cloak their actions. So although ďquantitative easingĒ
was universally derided historically, it was known by a different
name. Quantitative easing is simply a pleasant-sounding euphemism
for debt monetization.

All throughout
world history, debt monetization ended in ruin for the countries
that foolishly played this dangerous game. And it is exactly what
it sounds like. Central banks create new paper money out of thin
air to buy bonds, thus monetizing them. The big problem
is this grows, or inflates, the money supply. Whoever sold the
bonds to the central bank spends this new money, injecting it
directly into the economy.

The result is
inflation. When the money supply grows faster than the underlying
pool of goods and services on which to spend it, their prices are
bid up. The more new money the central bank creates to monetize
debt, the worse the resulting inflation. Even though its impact on
price levels isnít apparent immediately, it is inevitable.
Once unleashed, history has proven inflation will fully run
its course.

Thankfully there
is a refuge for the prudent, a safe haven to protect their
accumulated wealth from inflationís vile predations. All throughout
history, gold and silver have maintained their real purchasing power
as money-supply growth lifted prices all around them. They are like
battleships on the seas, no matter how high the ocean of paper
currencies under them rises they still float commandingly on top.

The Fedís brazen
debt monetization in recent years has already created massive
inflation. This deluge of new dollars that never existed before is
already baked into the pipeline, and its economic impact is just
beginning to be felt. Yet gold and silver have already seen
fantastic gains during the Fedís initial pair of quantitative-easing
campaigns. This new open-ended third one is very bullish for these
precious metals.

The best clues as
to how gold and silver will perform in this unlimited QE3 era
are probably found in how they fared during QE1 and QE2. So letís
dig into the entire history of the Fedís post-panic
debt-monetization campaigns, and then see how gold and silver did
within them. This first chart looks at the Fedís balance sheet,
which is where all the debt it has been monetizing ultimately shows
up.

Make no mistake,
quantitative easing is Fed Chairman Ben Bernankeís response to the
once-in-a-century
stock panic that slaughtered the markets in late 2008. Prior to
that, the Fedís balance sheet looked very different. For the first
8 months of 2008, it averaged $875b. Meanwhile the Fedís holdings
of US Treasuries, the most important component of debt monetization,
averaged $579b in pre-panic 2008.

The Fed started
aggressively buying assets before it launched what later became
known as QE1. Note the gargantuan spike in the Fedís balance sheet
between late August and late November 2008 in the dark heart of the
stock panic. Over that insane 3-month period where the flagship S&P
500 stock index (SPX) plummeted 42.2%, the Fedís balance sheet
skyrocketed a mind-boggling 145.5%! QE had begun.

It formally
started with a Fed press release on November 25th, 2008. Just three
trading days after the stock markets slammed into their primary
panic low (SPX 752), the Fed declared it would purchase $500b of
mortgage-backed securities and $100b of direct obligations of the
government-sponsored enterprises including Fannie Mae and Freddie
Mac. With all the other panic turmoil, this was widely overlooked.

In this area
chart, the three different bond classes the Fed purchased in its QE
campaigns are shown in different colors. Agency (GSE) debt is shown
in green, MBS bonds in yellow, and the all-important US Treasuries
in red. Note these three classes stack above within the
Fedís overall balance sheet in orange (which starts at zero). The
red Treasury band doesnít start at zero, but at the top of the
yellow MBS band.

Soon after, at the
December 16th, 2008 FOMC meeting, the Fed decided to slash its
benchmark federal-funds rate by a staggering 100 basis points to
zero. At that point the Fed had already expended all its
conventional monetary-policy ammunition. Everything it did after
that had to be some variation on debt monetization. And the great
inflationist mocked as Helicopter Ben didnít hesitate to rise to the
occasion.

The stock panic
should have ended in late October 2008, as the SPX had soared 18.5%
in six trading days ending on Election Day. But the panic
frightened half of Americans into voting for Barack Obama, a man who
had openly campaigned on a Marxist and Socialist platform. He
wanted to divide America with venomous class-warfare rhetoric and
envy, and then steal the fruits of the productive to bribe the lazy
for votes.

In the two days
after Obamaís victory, the SPX plummeted 10.0%! It would ultimately
plunge 25.2% over the subsequent couple weeks to a new panic low.
And that again should have been the bottom, but when the Obama
Administration took power in late January 2009 it terrified
investors. Many who voted for Obama thought he would be like
Clinton and be a centrist leader, but instead he swung sharply left.

As the US economy
remained very shaky after that once-in-a-lifetime stock panic, the
Obama Administration wasted no time in trumpeting asinine new
plans. It wanted to greatly hike already-crushing income taxes on
the investors, entrepreneurs, and small businessmen who create most
of the private-sector jobs in America. It wanted to radically
increase smothering regulations, and wanted Washington to take over
health care.

So by early March
2009 in the post-panic period when markets normally soar
following such fear super storms, the SPX had slumped 25.1%
year-to-date! The Fed was rightfully terrified, as it knows just
how important the health of the stock markets is to our entire
national psyche. So just over a week after those secondary
Obama-fear lows (SPX 677), the Fed vastly expanded its young
quantitative-easing campaign.

On March 18th,
2009, the Fedís Federal Open Market Committee released a statement
declaring it was nearly tripling its debt monetization. It
would purchase another $750b worth of MBSs to attempt to manipulate
mortgage rates lower. It would also double its agency debt buys
with another $100b. But the shocking part was it announced a
direct monetization of $300b worth of Washingtonís Treasuries!

While the Fed had
owned Treasuries before as the red area on this chart indicates, it
had never aggressively bought them up with the explicit goal of
manipulating general interest rates lower. This was the point when
debt monetization and the debasement of the US dollar really started
to concern prudent traders. And this ballooned the total size of
what became known as QE1 to a staggering $1750b!

You can see above
that the Fedís holdings of especially mortgage-backed securities
mushroomed dramatically during that QE1 campaign. By the time it
started tapering off in late June 2010, the Fed held $1129b worth of
mortgage debt at its peak. But with the stock marketsí strong
post-panic advance stalling out and correcting, the Fed couldnít
resist the temptation to expand its monetizations even further.

So shortly after
the SPX had corrected 16.0% over a couple months, on August 10th,
2010 the FOMC announced what would later be called QE2. This
actually spooked the markets, because the Fed was brazenly reneging
on its QE1 promise to let those debt purchases automatically unwind
as they matured. It announced it would roll over $300b in maturing
MBSs into Treasuries, expanding their monetization.

After that the Fed
remained on hold so it wouldnít be seen as political during the
crucial 2010 midterm elections. They were amazing, after ramming
through Obamacare when the majority of Americans opposed it the
Democrats were throttled. They lost 63 House and 6 Senate seats,
compared to an average of 30 and 4 in midterm elections. This was
the worst midterm defeat for any party
since 1938!

The state-level
races were even more lopsided. Republicans won 680
state-legislature seats, the most of any party ever even
beating the 628 the Democrats won in 1974 after Watergate. The US
had never seen a bigger midterm mandate for small government, yet
Obama and his party inexplicably decided to ignore it. But the very
next day, even this incredible news was overshadowed by the Fedís
latest FOMC decision.

On November 3rd,
2010, the FOMC tripled its new QE2 campaign to a total of
$900b. It said it would purchase an additional $600b worth of
Treasuries by the end of June 2011. This would work out to about
$75b per month, a metric to keep in mind later. On the chart above
you can see the radical ramp in the Fedís Treasury holdings during
that QE2 campaign. They later peaked at a staggering $1684b.

Provocatively QE2
proved a political nightmare for the Fed. World leaders and central
bankers, who normally never criticize in public, were openly angry
about this brazen monetization. It was called irresponsible
debasement. And the newly-elected Republicans attacked the Fed
aggressively for this, leading to calls for Congress to revoke the
Fedís monetary authority. Bernanke was stunned by this.

QE2 was highly
controversial because it directly enabled the profligate Obama
Administrationís wild overspending. The worldís biggest and best
bond-fund manager, billionaire Bill Gross, pointed out that a
whopping 70% of US Treasuries issued during the QE2 era were
purchased by the Fed! If the Fed hadnít created money out of thin
air to buy Obamaís debt, he couldnít have run such colossal
deficits.

So with Obamaís
unprecedented trillion-dollar deficits and scary debt growth
becoming a big political issue, the Fed had to lay low. Any more
direct monetizations of US Treasuries would be seized upon by
Republican lawmakers as proof Bernanke was in bed with Obama. So
even after QE2 ended on schedule in June 2011, the Fed was
understandably reluctant to rock the political boat very much.

But again the
stock markets, the key to American sentiment as a whole, were
flagging. After Obama reneged on his word and blew up a
debt-ceiling deal with Congress, Standard & Poorís downgraded
Washingtonís Treasuries in early August 2011. This was the first
time the USís AAA rating had ever been downgraded in
history! The next trading day the SPX plummeted 6.7%, and fear
skyrocketed.

As this selling
pressure cascaded into a full-blown correction, the Fed felt
compelled to act again. But it was very aware of the growing
political risks of its inflation, so it didnít expand its
monetization. Instead on September 21st, 2011 the Fed launched what
became known as Operation Twist. It sold $400b worth of short-term
Treasuries (under 3 years maturity) to buy $400b worth of long-term
Treasuries (6y to 30y).

Now since this
wasnít new monetization, merely shuffling capital around, it escaped
heavy criticism. Stock traders were disappointed it wasnít QE3
though, so their selling hammered the SPX down 8.6% in less than 2
weeks on this decision. And infuriating free-market proponents, the
FOMC statement openly said the purpose of this new campaign was to
attempt to manipulate long-term interest rates lower.

When Operation
Twist had run its course, the Fed decided to extend it to the end of
2012 at the FOMCís June 20th, 2012 meeting. The Fed would maintain
the yield-curve twisting rate of around $44b per month. Since this
extension would only run for six months compared to the originalís
nine months, this worked out to $267b. Despite heavy market
pressure for QE3, the Fed continued to refuse to expand QE.

But this all
changed last month, rather puzzlingly. During previous QE
announcements, the SPX had been near major lows after a panic or
serious correction. Yet when the FOMC met in mid-September 2012,
the SPX was just shy of a new 56-month high! Near the top of
its secular
trading range, stock-market upside was very limited. Would the
Fed actually waste its ammo while the stock markets thrived?

In addition, given
the political firestorm QE2 spawned would the Fed risk looking
political less than 8 weeks before one of the most-important
elections in US history? Somehow the stock markets had managed to
survive and thrive in the 15 months since QE2 ended. So why
risk the wrath of Republican lawmakers by attempting to goose the
stock markets which would
greatly benefit
Obamaís re-election bid?

But apparently the
inflationists at the Fed rightly fear a Republican Congress, which
could kill the Federal Reserve in a single vote. Instead of waiting
a couple more months until after this critical election, the FOMC
decided on September 13th, 2012 to launch QE3. And unlike the past
debt-monetization campaigns that had specific amounts and
timeframes, incredibly QE3 was open-ended with no stated limits!

The Fed was
sensitive to the criticisms it is enabling Obamaís insane debt
growth, so in QE3 it switched back to buying mortgage-backed
securities from Treasuries for the first time since QE1. And though
QE3 was open-ended, the $40b per month was pretty modest by QE1 and
QE2 standards. They weighed in at $1750b and $900b respectively,
yet a full year of QE3 would ďonlyĒ amount to $480b if not
expanded.

And it is this new
open-ended QE3 campaign that has investors and speculators so
excited about gold and silver. How will the precious metals fare
with potentially unlimited new inflation about to be
unleashed into the economy? One of the best ways to gain some
insights is to review how these metals did during the rest of the
Fedís QE. So these next charts overlay the QE milestones over gold
and silver.

During the time
when the Fedís original QE1 buying was underway, from late November
2008 to late June 2010, gold powered 50.8% higher! This is a heck
of a run, but it certainly wasnít all due to debt monetization.
Gold was beaten down during the stock panic too due to flight
capital from elsewhere igniting a
monstrous US
dollar rally. So gold was due to surge in the post-panic
recovery anyway.

QE2, which was
smaller but harder-core since it focused purely on monetizing
Washingtonís Treasuries, saw gold gain 24.7% during its lifespan.
This is certainly an excellent gain over less than a year.
Provocatively, just after QE2 ended gold surged for other reasons.
That was summer 2011 when Obama refused to honor a deal with the
Congress on reducing spending to secure a US debt-ceiling increase.

The first-ever
threat of Washington actually defaulting on its debt drove enormous
gold investment demand, but this metal soon grew
very overbought.
So it started correcting soon before the Fed launched
Operation Twist. And the fact that Twist wasnít QE3 really
accelerated this gold selling. Over the entire Twist timeframe with
no new monetization, gold drifted sideways to lower. But QE3 is
new monetization.

Since gold rallied
strongly during both QE1 and QE2, there is no reason not to expect
it to respond similarly in the Fedís young new QE3 campaign. 25% in
a year, especially if QE3 is expanded early next year as Fed
officials are already hinting at, seems pretty conservative given
goldís QE history. A 25% rally from the day before QE3 was
announced would catapult gold up to a record high above $2150!

And being smaller
and far more speculative than gold, silver has fared even better in
the Fedís debt-monetization era. This metal soared 79.5% during QE1
and a staggering 89.2% during QE2! Realize there was more at play
during these times than just quantitative easing though. During QE1
silver was recovering from
ludicrous
stock-panic lows, and during QE2 this metal experienced surging
popularity.

Still though given
silverís strong history of surging when gold does in inflationary
times, I donít think attributing 50% gains to the Fedís QE is
unreasonable. That is also in line with silverís oft-seen leverage
to gold of 2 to 1. Again assuming QE3 runs for a year, and gets
expanded in early 2013, a 50% gain in silver from the day before QE3
was announced would catapult this metal up near $50 per ounce!

Quantitative
easing is pure inflation, the classic debt monetization that
has proved so dangerous and ruinous all throughout world history.
Gold and silver have always thrived as currencies are being debased,
as theyíve proven abundantly during QE1 and QE2. And despite
starting out small, the open-ended nature of QE3 has really ignited
inflation expectations like nothing weíve seen in a long
time.

So the psychology
of QE3 is likely to drive big increases in investment and
speculation demand for gold and silver as long as the Fed keeps this
campaign alive. There is an excellent chance QE3 will ultimately
push both these metals to new record highs, perhaps as soon as next
spring. And of course as gold and silver power higher, the stocks
of the miners bringing these metals to market should amplify their
gains.

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The bottom line is
the Fedís quantitative-easing campaigns in recent years have been
hugely beneficial to gold and silver. No matter how the Fed wants
to present it, QE is classic debt monetization. Naturally the
precious metals thrive in times of inflation, and QE is as blatant
as inflation ever comes. The more dollars created out of thin air,
the higher they bid the far-slower-growing gold and silver supplies.

While QE3 started
out small, odds are it will be expanded considerably. After its
initial launch QE1 was nearly tripled, and QE2 was tripled. For
political reasons the Fed is reluctant to fully unleash its
inflationary plans all at once. And the open-ended nature of QE3
has reignited inflation expectations like nothing weíve seen in many
years. It is going to ultimately drive traders to flock into gold
and silver.